Spot The Speculators #68 – “Trev and Anna paid $1 million for a SFH near Main Street. They must spend $150K to make it livable.”

The story of ‘Trev and Anna’ is relayed and discussed at greaterfool.ca by Garth Turner, 27 Nov 2011, a must read for Vancouverites. Here is the core anecdote:
Trev and Anna paid $1 million for a place near Main Street. Sadly, it was unrenovated, so they must spend $150,000 to make it livable. “We plan to stay here 10 years,” Trev adds, “and we were fortunate enough to put down 50%.
“We’ve set aside an RESP for our kid maxed out to the level the government will contribute. I have a limited partnership investment of $50,000 which is projected to provide us with a 7% return. Our combined income at the moment is 120k per year. The house has a separate suite which will provide us $900 per month income. If times get tough then we can rent a spare bedroom to a student for $700. So, we will have $50k after renovations to invest.
Should we seriously consider selling the house when the renovations are complete, rent for a while and then re-invest? The concern is that we will be house rich. If we are planning on staying there for 10 years does this still apply?”

So:
House value (generously presumed) $1.15M.
Mortgage $500K.
Other assets $100K.
Networth $750K.
Percentage of Networth in RE 153%.

These guys are gambling on ongoing price increases.
They will potentially lose ALL of their equity in the coming crash.
(These houses will very likely sell in the $500K-$550K range again at some point).
The idea of them overextending themselves this much into a ‘livable’ Main Street SFH with tenants in the basement and perhaps one in a bedroom just boggles the mind. – vreaa

59 responses to “Spot The Speculators #68 – “Trev and Anna paid $1 million for a SFH near Main Street. They must spend $150K to make it livable.”

  1. This isn’t on topic, but if anyone can post the link so the rest of this story I’ve excerpted below (from the Wall Street Journal) is visible, it might show that Iceland, unlike Vancouver, is not completely for sale to any bidder. It looks like the story might also relate to another from the WSJ recently about the wealth of Communist Party elites.

    REYKJAVIK, Iceland—Iceland on Friday rejected a controversial application by one of China’s wealthiest entrepreneurs to purchase land for a resort, saying there was no precedent for a foreigner to own such a large tract.

    Developer Huang Nubo, a 55-year-old former Chinese government official, had been ready to pay 1 billion Icelandic kronur (about $8.8 million) …

    • Sorry Vesta, no link… But I can say this… Intended Icelandic purchase was, in all probability, more about telemetry/’funny’ antennae than ‘luxury resorts’. Hence declined. It’s a latitude/circum-polar orbit, circular error of probability thang….

      http://tinyurl.com/cttbb8

    • “former government official” = thief.
      I don’t care what other think about this, but in my experience with post communist countries, every time I met a wealthy “former government official” from a post communist country, his wealth always came from hollowing out a state owned enterprise or a private enterprise that existed only for overpriced government contracts. These people are usually proud of their achievements, thought they like to morph into “serious” and “honorable” entrepreneurs at some point.

      • youre a racist

        above post by bubbly is a racist post

        [it should be pointed out to infrequent readers of these pages that ‘derp’ should be taken as being ironic and playful with these interjections. Like a court jester. – ed.]

      • Government officials should be a protected race? 😉

    • From what I heard that this mr. Huang was planning to build 5000 houses in Iceland and marketed to only Chinese. As you know Iceland is the hottest immigrant destination for rich Chinese because its excellent public education.

      Good for you for keeping an watchful eye on those chinese.

      我一见你就笑

      • For what it’s worth, I have been to Iceland and it is one of my favorite countries in the world.

        I would wager that the average level of English comprehension is higher in Iceland than it is in Richmond.

      • above post is racist

        [it should be pointed out to infrequent readers of these pages that ‘derp’ should be taken as being ironic and playful with these interjections. Like a court jester. – ed.]

      • Good for Iceland – I think they’ve had enough of getting screwed by their own and then bend over for the Chinese.

  2. Renters Revenge

    Subtract the mortgage amount from the house “value” to get net worth in their home.
    $1,150,000 – $500,000 = $650,000
    $650,000 / $750,000 = 87% of net worth

    • Okay, we see that.
      The 153% is, we would argue, a more accurate number. That’s how much of their networth actually is ‘in’ RE.

      • How is it “more accurate”? How could it ever exceed 100%?

      • Renters Revenge

        Not really, the mortgage is an asset for the bank but is a liability for the mortgagor. If you consider the situation when the mortgage is paid off, at that point, and everything else being equal, their net worth would be 153% in RE. So yes, they have committed a sizable portion of their future net worth to one asset, but their current mortgage obligation cannot be considered part of their current net worth.
        Either way they have made an incredibly stupid financial decision and will live to regret it. Unfortunately for all of us they are not alone.

      • Anonymouse asks “How could it ever exceed 100%?”

        If, for instance, somebody with a net-worth of $200K, all in cash, uses it for a downpayment on a $1M house, taking out a $800K mortgage, they then ‘own’ RE that is worth 500% of their net-worth. Their net-worth is highly leveraged to the RE market.
        Sure, you could say that their net-worth is “100% in RE”, but we think it is far more telling to point out that the market price of their RE represents 500% of their net-worth. Both statements are true, but the latter gives more information, doesn’t it?
        (PS: ‘Telling’ would have been a better word for us to use than ‘accurate’.)

  3. pricedoutfornow

    We sure are delusional in Vancouver, for thinking that somehow we’ve “made it” in life if we own a mortgaged-to-the-hilt house and still have to rent out a basement suite AND possibly take in a foreign exchange student just to meet the mortgage payment. Meanwhile, the inlaws consider me a loser because we pay 15% of our household income on rent and save more than $1000 per month. We shall see who the real losers are in time…..

  4. Renters Revenge

    Here’s the real kicker: A $650k mortgage with a 4.25% interest rate amortized over 25 years come with a monthly nut of $3,500. Over 25 years they will pay $400k in interest alone. That’s assuming no rise in interest rates and doesn’t include property taxes, maintenance, and insurance. They are banking on an awful lot of price appreciation.

  5. Renters Revenge

    Sorry, mortgage amount is $500k. Still adds up to $310,000 of interest payments.

  6. Vancouver in the Rearview

    No sympathy here. Anyone who thinks that sort of house of cards is a sustainable approach deserves what they get. It is about time people learn to be accountable for their actions.

  7. another story being made up by Garth. would you like to buy my farm?

    • Do you really think this is a fabricated story?
      Do you not believe there are people doing precisely this in Vancouver?

    • These pretzels are making me thirsty

      All this talk about net worth and debt making you nervous about your cardboard box in Vancouver ? eh Fred!!

    • could be true Fred. If Garth made this up he’d probably say they put zero down instead of 50%.
      2 br rental of a renovated suite in Main area would go for 1500-1800/month with never a vacancy. Are we forgetting this?

      • Actually, ‘Diablo,’ we’re relying on their statement that the suite will rent for $900 a month. (Read the story please, if you want us to pay any attention to your comments.) They never say how big the suite is. You can rent a two-bedroom above-ground (above-ground! such luxury!) suite in much nicer parts of town for 1350-1600/month.

    • I know for a fact that Garth doesn’t make up (at least not all) the stories on his site. I sent him an email awhile ago about a family struggling with too much real estate debt and he published it nearly word for word. And no, I didn’t make up the story either. I wish I had, whenever I think about this family’s struggle it makes me feel just sick how things can go really, really wrong when bad decisions are made.

  8. Another measure might be VaR, with a 10 year horizon on their equity. These days I would invert the PDF, it’s that crazy.

    Choose 100 of these families, I can predict with high degree of accuracy 2-3 will be wiped clean. Odds of even more screwing the pooch are not insignificant. Scary stuff, vreaa.

    • VaR over long holding periods is not impossible but it’s certainly problematic especially using historical price data and the conventional wisdom that house prices only go up over the long run. An additional difficulty is estimating the correlation between interest rates and home prices. If one assumes that the correlation remains negative as interest rates increase, then a mortgaged buyer loses on two fronts at the time of renewal. Furthermore, there is likely a correlated problem with the rental suite income at the very least. All these correlated factors will tend to push the cash-flow at risk value into your beloved pdf tail. I wonder if the banks use this line of thinking when they are assessing their credit capital at risk. Based on the equity performance of the banks over the past 4 years, I sincerely doubt it.

  9. More thoughts about this couple and the market:
    $750K net-worth and $120K annual household pre-tax income puts them at what percentile by wealth for Canadian citizens?
    [In 2005, median Canadian family networth was $230K. In 2007, the median (but after tax) income for families was $61K.]
    The point is, this couple is doing relatively well on paper, they are perhaps in the top 15% of Canadians by financial wealth. (Anybody have up-to-date percentile tables?; we’ll edit in if we find them). Many Canadians would look at them and call them ‘rich’.
    But, when it comes to them facing their housing options here in Vancouver, they are reduced to buying a ‘livable’ house near Main, and, essentially running a rooming house, with tenants in their basement and in their own actual living space. Furthermore, the quality of schooling their kids will get is likely hit or miss.
    This is what is so troublesome about housing prices here: it’s not as if citizens like Trev and Anna aren’t humble enough to accept modest living standards, it’s that they get so much less here than they would elsewhere (even in other parts of Canada, during a nation-wide housing boom/bubble).
    That differential simple can’t persist for too long.

  10. “The house has a separate suite which will provide us $900 per month income”.

    someone should tell this poster that $900/month for a main area suite is far under market.

  11. havent we been doing that since the start of this blog feb 2008?

    • Actually, we’ve preferred to look at the very big picture here, that of the massive speculative mania.
      Nickles-‘n-dimes can be important, yes, but if you look after the hundreds-of-thousands of dollars, the nickels-‘n-dimes tend to look after themselves.

  12. actually, we’re talking about how much money this couple needs to service this debt, which includes monthly revenue from suite. Not relevant?

    • Of course it’s relevant. It’s called “add to income”. Given your astute observation, let’s generously boost their salaries to $130K.

  13. The one thing that strikes me about Vancouver real estate in general is how it’s somehow good policy to have basement suites; basically this family owns a duplex and are letting part of it, it’s not a single-detached home by a long shot. That may be the best use of existing structures but it still seems odd –to those who aren’t from Vancouver, anyways — that a family needs to be part-time landlord to afford an urban lifestyle.

    When we lament that families are moving away from the core because properties aren’t affordable, well, maybe some treasure their basements enough to “consider the alternatives”. It’s hard to imagine a scenario where current lots don’t carry a utility premium with laneways and basement suites priced in. Density is upon us, I’d argue it has been showing up in prices for close to a generation now. (Just to make things more confusing.)

  14. “Both statements are true, but the latter gives more information, doesn’t it?”

    No, I don’t think both statements are true – because you’ve re-defined “net-worth” from “total assets minus total liabilities” to something else. You can’t count 100% of the value of their house towards their net-worth whilst it still has a mortgage on it.

    • Um… who is “count(ing) 100% of the value of their house towards their net-worth whilst it still has a mortgage on it”? We certainly aren’t.
      We’re pointing out that their house (in the 200K-down, $1M house example I gave above) has a market price of 5 times their entire net-worth (it’s worth 500% of their net-worth). Don’t you agree?

      • “Don’t you agree?”

        Yes, but saying that the market value of their house represents a 5x multiple of their net-worth is entirely different to saying 500% of their net-worth is in real estate. And I imagine the value of most homes exceeds their owners’ net-worth by some factor. Because houses are usually bought using leverage.

        [Okay, it seems our differences on this one are largely semantic… I’d see those two statements as similar, you see them as different. For me, the leverage results in them being ‘in’ RE to the tune of 500% of their net-worth; that’s how I’d say it and consider it.
        Regarding leverage, yes, houses are usually bought with leverage, but note how we’re now seeing leverage as the norm. In typical times, people pay off mortgages and have other assets, so their homes, by the time they’re in their 40s or 50s, and definitely by the time they retire, make up only a portion of their net worth. But we are living in such perverse times in Vancouver that it is the norm for people’s entire net-worth (or more) to be ‘in’ RE. Even many retirees have homes that have a market value of more than their entire net-worth.
        This same prevalent leverage is the factor that will make the bust so gruesome. The sound financial future of many Vancouverites is overdependent on RE.
        We’ve made this point elsewhere, but here it is again: Many who consider themselves prudent with money, who would never dream of buying investment assets on margin, merrily borrow at 10:1 leverage to buy very overinflated RE. It’s remarkable. -vreaa.
        ]

  15. “…how it’s somehow good policy to have basement suites”

    I say we crack down on basement suite dwellers and the city force evictions. This will force prices in line with real values (i.e. no speculative or added value for this additional income). Of course, we’d have a war between renters for space and people living in shelters and on the street – but at least it’ll bring each detached home value down by 100K each.
    And while were at it let’s tell homeowners that they can no longer build anything in their backyard, regardless of zoning. This way there won’t be any added use for this space and home prices will not add value.
    How about we also restrict foreign ownership so detached price demand wanes and falls in line with local incomes.
    Why don’t we put a cap on any redevelopment that changes use of land from detached single family to multi family (Cambie corridor).
    And we should also start adding single family subdivision in the agricultural land reserve to satisfy demand
    Did I miss anything?

    • Yeah, you missed something, you forgot to add “/sarcasm”.

      Interestingly, factors such as basement suites, laneway houses, foreign buyers, and development restraints all influence the markets but they do not explain prices. Each have had direct but relatively small incremental effects on prices. Removing any or all of them would only have an appreciable effect in that the act may have a psychological effect on the speculative mania. Speculative buying (buying based on the premise of ongoing price strength) has had a far larger contribution to price run up than any or all of these factors.
      To prove this, just watch: None of these factors will be removed, but the market will collapse regardless.

    • Formula 1: About basement suites: To an outsider, the presence of, and apparent financial need for, basement suites in many single-family houses highlights the absurdity of current prices. In Vancouver, you pay more money than elsewhere, plus you have to share that house with a tenant, which elsewhere you have to put up with rarely. People who haven’t internalized Vancouver lunacy might say, “But if I don’t get the house for myself and my family, why should I pay so much money?” But in this market, a basement suite raises the “value” of the house. (The city and province understandably love this system, and so give people incentives to include a suite in new builds, though they don’t really care whether anyone ends up living in it or not; the higher assessment is what they’re after.) A comparable aspect of this market: an oversized house on a small lot is more valuable than a house big enough for most families, together with a yard and some sense of privacy from your neighbors. Apparently. Another reason why It’s Different Here. What I wonder is whether at some point such aspects of the market will be self-correcting; e.g. as the west side loses more and more of the green space that makes it (for some) a desirable place to live, whether demand for houses there will moderate.
      Constructing duplexes and triplexes when SFHs are demolished seems a better way actually to create density and to decrease the social costs of making amateur landlordship a condition of owning a SFH. If you can’t afford a SFH without being an amateur landlord, you can buy half of a duplex instead. (In actual practice, as I’ve observed it, rebuilds with suites increase density only marginally at best.)

      • I agree. For a Calgary SFH, a basement suite deducts from the value except occasionally in the case of a proper up/down with separate utilities and no shared facilities. A lot of renters would rather pay more to be able to rent the whole house. People generally don’t pay extra to have a stranger living in their basement for obvious reasons.

    • eyesthebye/diablo/Rusty/Formula1

      You’re a middle-aged, hockey card-collecting social worker. What do you know about zoning and redevelopment? Nothing? That’s what I thought. STFU. Thanks.

  16. pricedoutfornow

    I’ve often wondered why families subject themselves to this: buying a house which they have to share with several strangers to meet the mortgage payment. And the parking on the street in front of the house is the pits, because of all the suites in the area. Is it so they can have a yard? But still, some of the people I know who live in SFHs don’t even have yards, it’s taken up by a parking garage plus paved parking spots to accommodate all the residents of the house. Or the yard is postage-stamp sized, you could cut the grass with scissors. I wonder why they even bothered to buy the house in the first place and stretch their budget so, wouldn’t they get far more value out of a townhouse they wouldn’t have to share with strangers, plus no parking hassles AND if you pick your property correctly you might even get a little yard. Sure, the SFH may be 5 bedrooms and 3 baths, but really, the homeowners only get use of 2 beds and 2 baths (give or take one or two bedrooms and baths), which is the equivalent of the condo I live in! Don’t people realize there is not much value in owning a home in such instances? We are so delusional in Vancouver it’s not even funny.

  17. Some people rent out their basement’s ‘because they can’ not because they have to. You have income generating potential and your RE is priced (and taxed) accordingly. If someone offers to pay your mortgage while you double up your personal savings I say you’d be silly not to.

    It can be a lot of fun to play with a compound calculator when you have $900-1300/mos of passive income every month:

    http://www.moneychimp.com/calculator/compound_interest_calculator.htm

    Not all renters want to live in a tower either.

    • Not true. Based on your point, we should see many people living in their basement to increase their monthly “passive income”. Bottom line, if you are buying a house you shouldn’t be so hard up that you have to rent part of it out just to make your financial goals. You probably need to have been a landlord with basement tenant for at least 5 years to truly understand. That said, only in Vancouver is a partially-finshed basement considered in the square footage of a home. I was blown away at all those “2000 sq ft” bungalows on the East side!

      • I’ve been an up/down landlord for 4+ years and over that period have invested over 60K into my TFSA and RRSP because of it. No bad tenants, no damages beyond basic wear and tear and don’t foresee any major improvements required for at least 10 years.

        Definitely not ‘hard up’, certainly no more so than those living side-by-side in a duplex or up/down in a tower. I just don’t need the space and am capitalizing on it. I’ve actually considered moving downstairs (it’s a nice suite) but I like my deck in the summers with the mountain view.

        Maybe in Calgary this wouldn’t work, I don’t know, but I don’t live in Calgary so I don’t care.

      • I hated the experience of renting my basement almost as much as i hated living in somebody’s basement in Vancouver. But in Cowtown you will not find anybody desperate enough or stupid enough to pay $1500 to live in a basement. Maybe in Vancouver, it’s so hard to earn a living that one is willing to tolerate a tenant because of the relatively attractive rent.

      • Sorry, your post said $1300 which I still consider ludicrous for a basement. That’s what people call “best place on earth”? That’s just messed up!

  18. Agree with Airedales, Calgary has a different midset and also…affordability so people don’t have to have a basement suite to pay for their mortgage. Vancouver it seems it is a necessity. Vancouver has had a longer history with basement suites too. Many homes on the westside had suites when I was growing up and also attending UBC. It is hard to put a “price” on the benefit or cost to owning a single family home with a suite. Honestly I don’t know if I would want to right now.

    • Also, shortage of rentals in desirable non-dt areas (West Side and East Side). Not sure if this is the case in Calgary. I understand there are different dynamics. RE is still local.

      As Jesse says, if every Vancouver lot is de-facto multi-family is this another fundamental support for the market?

      Someone else could write a thesis on the socio-economic effects of basement suites in Vancouver. I am just trying to profit from it.

  19. Back in the day, lots of houses were like Blammo’s. One downstairs suite, with the owner enjoying a nice additional income.

    In the last few years, its changed. More often what you think is a SFH with a suite is, in fact, a nasty rooming house like this one at 4163 Miller St.
    http://vancouver.en.craigslist.ca/van/roo/2726109388.html
    Google the address. You can’t tell which house it is, but it looks like a fairly nice neighbourhood by crappy Vancouver standards.

    Streets like Miller St. should have been redeveloped decades ago. There should be townhouse and apartment buildings there. Why not?

    Some text from the ad, in case its removed:

    [text here removed at Mike Davis’ request, and with editorial agreement. -ed.]

  20. “if every Vancouver lot is de-facto multi-family is this another fundamental support for the market”?

    when women entered the workforce in the 60-70s it resulted in an inflationary trend. Those who had one breadwinner soon found themselves at a distinct disadvantage to these two income households. In some respects, families were induced to add the extra income to “keep pace with the Jones’s”
    Same trend with detached housing here. In order to compete for housing, buyers found it necessary to add income to their home by way of a secondary suite or lose out on the race for this scarce property class. This is classic progression of demand for scarce commodity…continuing to adjust to incremental need for more income to secure it. I think the next phase (or current) might be for families to pile on additional income earners i.e. not just two incomes, but 3 or 4, or…
    So to respond to the above comment. The Vancouver property is not a de-facto secondary suite so much as it is the need to add more and more income to the purchase to outbid rivals for the scarce commodity.

    • that’s classic bubble formula – think about what you are saying. Prices reach a maximum and then decline well before your 3 incomes per home because your China credit bubble is imploding. Society isn’t as stupid as you’d like to think.

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